National Post (National Edition)
Horror at the border
IT’S A REPUBLICAN TAX PLAN THAT WOULD HELP TRUMP ON JOBS. IT SHOULD BE CANADA’S TOP CONCERN.
“Toyota Motor said will build a new plant in Baja, Mexico, to build Corolla cars for U.S. NO WAY! Build plant in U.S. or pay big border tax.”
With this tweet, Donald Trump got the attention of not only of Toyota and Mexico, but also some astute Canadians. The realization began to dawn on them that Trump’s promise to rip up NAFTA was not the only threat to jobs and investment in Canada. Some may have even realized that the “big border tax,” if adopted, could turn out to be an even bigger concern. Indeed, the proposal has the potential to hurt millions of Canadian workers. It would be a horror story for Canada.
The border tax is not a trade policy. It is a part of a sweeping corporate tax reform that originated with Paul Ryan, Republican Speaker of the House and Kevin Brady, chair of the House Ways and Means Committee.
They have yet to fully convince Trump; he said this week he found the border tax “too complicated.” But they’re trying.
The Ryan-Brady plan includes a cut in the corporate tax rate from 35 per cent to 20 per cent. It also includes some big changes in the way the corporate tax works: It eliminates deductions for interest payments; it makes capital investments fully deductible in the year they’re made; most importantly, it makes the cost of imports non-deductible and allows companies to exclude export revenue when calculating their tax burden.
U.S. companies would not be able to deduct the cost of imported goods from Canada either as inputs to their own production or for final sales to U.S. consumers. The cost of inputs purchased from U.S. companies would be deductible, providing a huge cost advantage to sourcing inputs from within the United States rather than from abroad. The result would be equivalent to imposing a 20-per-cent tariff on imports from Canada and elsewhere.
U.S. companies that export to Canada, where they compete with Canadian companies, would no longer have to pay corporate tax on their export revenues. As a result, U.S. companies would either see a large increase in their profit margins on exports or they could cut their prices, forcing Canadian companies to do the same.
The border tax would be assessed on almost $400 billion of Canadian exports. Canada’s export industries — energy, motor vehicles and parts, minerals and metals, and forest products — would be placed at a disadvantage relative to U.S.-based competitors. Almost $300 billion of U.S. exports to Canada would not be subject to corporate tax. Canada’s importcompeting industries — food products, machinery and equipment and other consumer goods — would face much stiffer competition from U.S. exporters.
Such sweeping U.S. tax changes seem radical but they have support from respectable U.S. economists including Harvard University’s Martin Feldstein, who presented this example to explain the new border tax: A U.S. importer that pays US$100 to import a product from Canada can, if there is no border tax adjustment, sell that product in the U.S. for US$100. But with the border-tax adjustment, the US$100 import cost is not deductible from the corporate tax base. The price would have to be US$125, of which US$25 would go to pay the 20-per-cent tax. But, Feldstein asserts the 25-per-cent price increase be fully offset by an appreciation of the U.S. dollar. With a 20-percent corporate tax rate, that means that the value of the U.S. dollar would rise by 25 per cent. This means that the Canadian dollar would need to drop to 60 US cents, cutting the real purchasing power of Canadians.
Some U.S. economists oppose the border tax. Lawrence Summers, former treasury secretary in the Clinton Administration, argues that the tax change would likely harm the global economy in ways that reverberate back to the United States. It would be seen as a protectionist act that violates U.S. treaty obligations. The WTO has been clear that income taxes cannot discriminate to favour exports. U.S. trading partners would likely retaliate with their own protectionist measures. Meanwhile, the anticipated sharp appreciation of the U.S. dollar would do huge damage to U.S. dollar debtors, provoking financial crises in some emerging markets.
That Republicans might persuade Trump to adopt the border tax as a way to fulfill his election promises to bring back manufacturing jobs should be Canada’s top concern. It is less clear, however, what Canada could do about it.
Obtaining an exemption from a U.S. corporate tax reform would be a tall order. Presumably, Canada would need to adopt a similar corporate tax framework to that of the U.S. and seek to have Canadian goods treated the same as U.S. goods for corporate tax purposes in both countries. That would take a lot of doing.
Another alternative would be to join together with other U.S. trade partners and challenge the border tax at the World Trade Organization.
A last resort would be to grin and bear it and accede to Feldstein’s solution of letting the Canadian dollar weaken about 20 per cent further against the U.S. dollar to keep our exports from getting priced out of the U.S. market.